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Cover Story : Control Issues

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Change-of-control agreements didn’t go away during the lull in M&A;, says Friske of Towers Perrin. “The golden parachutes have been there since the dot-com era. They are fairly standard across US companies.” Many of these agreements don’t get much attention or publicity, however, until after a takeover is completed.

That could be about to change, however, under new disclosure rules proposed by the Securities and Exchange Commission that would require companies to spell out total pay and benefits, including stock options and pensions, for top executives. For the first time, companies will have to make a calculation of the value of parachute awards, most likely effective with the 2007 proxy season.

“All board members will be far more attuned in the future to what the payments will be,” says Ann Costelloe, leader of Watson Wyatt Worldwide’s San Francisco-based executive compensation practice. “But good executive leadership is not easy to find, and CEOs should be paid commensurately with their skills,” she says.

Increased disclosure of large exit agreements could tend to increase compensation further, Costelloe says, citing the me-too effect. “But the greater influence on the size of these agreements is the market for talent and the link of pay and performance,” she says.

Institutional investors don’t like golden parachutes because they fear that a CEO could be induced to sell a company at a price that is too low, Costelloe says. A survey last year by Pearl Meyer & Partners, New York-based compensation consultants, found that institutional investors say CEOs of major US companies are overpaid and that golden parachutes serve no useful corporate purpose. Three-quarters of the respondents at 88 major institutional investors said compensation for CEOs was too high, and not one thought CEOs were underpaid.

SEC SHINES SPOTLIGHT ON EXECUTIVE PAY AND PERKS

As his first major initiative as chairman of the US Securities and Exchange Commission, Christopher Cox on January 17, 2006, unveiled proposed new rules that will require companies to clearly report pay and benefits, including stock options and golden parachutes, for their top five executives and all directors. The agency said it is trying to help investors see how much of the money they invest in corporations is being paid to top executives. “Companies will have to make a calculation of what the parachute payment will be,” says Don Delves, president of the Delves Group, a Chicago-based consulting firm. “This has never been disclosed before,” he says.

Compliance with the quantification requirement could be difficult and confusing, according to corporate lawyers. Companies would be required to make assumptions about the dates of an employment termination or proposed transaction in order to calculate change-in-control payments. They also would have to estimate the price of the transaction or stock price at the time of termination and consider potentially complex future tax positions of the executives, according to a memorandum by Wachtell, Lipton, Rosen & Katz.

The new rules for company proxy statements, which likely will be adopted this spring following a 60-day comment period, would require companies to explain in plain English how they arrived at a total compensation figure, including equity holdings, pensions and post-employment arrangements. The Compensation Committee Report will be replaced by a new compensation discussion and analysis section in the proxy statement. A summary table will list a total annual compensation figure, salary and bonus, stock-based awards, long-term incentive cash payouts and other compensation. The latter category will include all perks with a value of more than $10,000, instead of $50,000 under current rules. Supporting tables and narrative will describe how specific compensation levels are determined. A second set of tables will elaborate on outstanding equity awards and vesting terms. If adopted, the new rules would be effective with the 2007 proxy season.

Analysts say that while increased disclosure is a necessary first step, it won’t put a cap on rising executive compensation. Boards may take a longer and harder look at the whole issue of accounting for the expense of stock options, however, while shareholders will remain worried about the potential dilution of their holdings. In a survey of institutional investors last year, Pearl Meyer & Partners said nearly 80% of respondents regularly consider dilution in making decisions on whether to buy or sell a stock. Executive stock ownership and corporate governance were cited by about 65% of those surveyed as being important investment criteria.

The proposed new pay-disclosure rules would not apply to non-US companies that register with the SEC to sell securities in the United States. They would require that a US company disclose whether each director or nominee is independent and describe any relationships that were considered in making such a determination. Companies also would have to disclose audit, nominating and compensation committee members who are not independent. —GP